Fitch Rates Salem Health, OR's Series 2016 Bonds 'A+'; Outlook Stable

October 12, 2016 02:04 PM Eastern Daylight Time

SAN FRANCISCO/--(BUSINESS WIRE)--Fitch Ratings has assigned a 'A+' rating to the approximately
$185,120,000 Salem Hospital Facility Authority, OR revenue refunding
bonds series 2016A issued on behalf of Salem Health (Salem). In
addition, Fitch has affirmed the 'A+' rating on Salem's outstanding
debt, which is listed at the end of this release.

The Rating Outlook is Stable.

The series 2016A bonds will be fixed rate and bond proceeds will refund
Salem's outstanding series 2006A, 2008A, and 2013A&B bonds. The final
maturity is being extended to 2046 since there is additional average
life remaining. The extension on the final maturity as well as interest
rate savings significantly reduces MADS to $15.9 million from $22.1
million. In addition, the sources of funds include the release of the
series 2008A debt service reserve fund. The bonds are expected to price
on Oct. 25.

SECURITY

The bonds are secured by a gross receivables pledge of the obligated
group (OG). There is an amended and restated master trust indenture
dated Nov. 1, 2016, which will be effective at closing of the series
2016A bonds.

KEY RATING DRIVERS

SUSTAINED STRONG PERFORMANCE: Since Fitch's last rating review in
February 2016 when Salem's rating was upgraded to 'A+' from 'A', Salem's
financial performance continues to be very strong and mainly driven by
benefits from its lean management system. The refinancing provides
further financial cushion with a significant reduction in debt service.
Operating EBITDA margin was 13.4% in fiscal 2016 (June 30 year-end) and
operating EBITDA margins are expected to be sustained around 12%.

AFFILIATION WITH OHSU: Effective November 2015, Salem affiliated with
Oregon Health and Science University (OHSU; rated 'AA-'/Outlook Stable)
under a Joint Management Agreement. While Salem and OHSU will remain
separately obligated on their debt, the clinical enterprises are
operated as a single entity with a common management team and shared
bottom line (operating income).

DOMINANT MARKET SHARE: Salem maintains a dominant market share position
of almost 80% in its primary service area, which includes the cities of
Salem (the state capital) and Keizer. Volume growth has been strong and
driven by Medicaid expansion as well as an aging population.

SOLID LIQUIDITY POSITION: Liquidity metrics have consistently grown and
compare favorably to Fitch's A category medians. At June 30, 2016, Salem
had 296 days cash on hand and 178.7% cash to debt compared to the 'A'
category medians of 215.5 and 148.6% cash to debt, respectively.

ADDITIONAL DEBT CAPACITY: With the refinancing, Salem has created
additional debt capacity at its current rating level for future growth
plans. No additional debt is expected in the next two years, but there
is longer-term planning underway for potential additional bed capacity.

RATING SENSITIVITIES

FLEXIBILITY AT CURRENT RATING LEVEL: Salem Health's current financial
performance provides flexibility as it manages strong demand. The
maintenance of current operating performance and further growth in
liquidity could lead to upward rating movement over the medium term
depending on the size and scope of any large scale capital plans.

CREDIT PROFILE

Salem Health Hospitals and Clinics includes Salem Health (fka Salem
Hospital), a 413-staffed bed hospital located in Salem, OR,
approximately 45 miles south of Portland, as well as other healthcare
related entities. Salem Health is the only member of the OG and
accounted for 98% of total assets and 96% of total revenue of the
consolidated entity in fiscal 2016 (June 30 year-end). Fitch's analysis
is based on the consolidated entity.

Salem had $741 million in annualized total operating revenue for fiscal
2016. Salem changed its fiscal year end to June 30 from Sept. 30 in
2016, and the audited period for fiscal 2016 is for a nine-month period.

Strong Operating Performance

Salem has been using the lean management system since 2010, which aligns
the whole organization in reducing waste. There are visual management
tools for the six main strategies (financial performance, quality,
patient experience, employee engagement, physician engagement, and
population health), which cascade down to the department level.

The lean management tools and good volume growth has led to very good
operating performance with a 13.4% operating EBITDA margin in fiscal
2016 compared to 15.4% in fiscal 2015, 12.2% in fiscal 2014 and 12.9% in
fiscal 2013. Salem has also implemented a rolling forecast (versus
budgeting), which allows the ability for more timely responses to any
issues that arise. Salem has a target of maintaining at least 12%
operating EBITDA margin.

For the annualized fiscal 2016 period, emergency room visits are up 6%
while surgeries are flat at 0.3% and admissions are slightly down at
negative 0.7% compared to the prior year period. Salem maintains one of
the busiest emergency rooms in Oregon (over 125k for fiscal 2016), and
volume growth has been accommodated by improved throughput.

OHSU Affiliation

OHSU is based in Portland, Oregon and is the state's only health science
university and major academic health center. In addition to the Schools
of Medicine, Nursing, and Dentistry, OHSU operates 564 beds in its two
hospitals (OHSU Hospital and OHSU Doernbecher Children's Hospital) and
provides highly complex tertiary and quaternary care with a case mix
index over 2.0. OHSU has trained over a third of the physicians in the
state, which provides a good foundation for the physician integration
expected with the affiliation.

OHSU and Salem entered into a 40-year joint management agreement in
November 2015, which states that the clinical enterprise will be jointly
managed by a common management team (OHSU Partners). The academic and
research missions of OHSU are excluded from this. OHSU Partners'
executive management team includes individuals from both OHSU and Salem
and the hospitals of both entities will be managed on a combined basis
with integrated financial and capital planning. The OHSU Partners
budgets have to be approved by both the OSHU board and Salem board. The
profitability (operating income) of the combined entity is split based
on each entity's historical share of financial performance (Salem 19%,
OHSU 81%). The expectation is that growth will be greater as a combined
entity as the entities leverage each other's resources, capacity, and
capabilities. For fiscal 2016, the operating margin split resulted in
Salem recording an expense of $8.26 million.

Fitch views this relationship favorably as it allows Salem to be part of
a larger system while maintaining local control. However, effective
implementation and consensus on a shared strategic vision can be
challenging achieve. Initial work is still underway, and over the lab,
pharmacy and supply chain are expected to be standardized over the next
18 months. There are two potential hospitals that will be joining OHSU
Partners.

Solid Liquidity

Salem's liquidity metrics are solid for the rating level, and
unrestricted cash and investments have steadily increased year over year
since fiscal 2012. Unrestricted cash and investments totaled $530.3
million at June 30, 2016, which equated to 296 days cash on hand and
178.7% cash-to-debt from 255.1 and 114.6%, respectively at fiscal
year-end 2012.

Capital Spending

Capital spending totaled $51.3 million for fiscal 2016 (1.6x
depreciation expense) and strategic capital included investing in a new
outpatient rehabilitation building as well as the build out of 40
additional beds in shelled space. These beds will open in October 2017;
however, two more floors need to be renovated so the additional capacity
will not be on line until the end of 2018. The fiscal 2017 capital
allocation model results in $69 million of total spend with $39 million
of strategic capital planned. A master facility plan is underway with
the potential long-term need for additional bed capacity being assessed.

Additional Debt Capacity

Fitch believes Salem has created additional debt capacity at its current
rating level due to the refinancing. MADS drops from $22.4 million to
$15.9 million. MADS as a percentage of revenue declines to 2.1% from 3%
in fiscal 2016 and compared to A category median of 2.7%. MADS coverage
is strong at 6x in fiscal 2016 and 5.6x in fiscal 2015, which improves
to 8.5x and 7.9x, respectively on the pro forma MADS. The aggregate debt
service schedule is level.

As of June 30, 2016, Salem had $296.7 million of debt outstanding. With
the refinancing, Salem is removing the bank renewal risk as the series
2013A&B direct bank loans are being refinanced. Post series 2016
financing, the debt mix will be 72% fixed rate and 28% variable rate.
Salem's variable rate exposure totals $75 million (series 2008C) and the
variable rate demand bonds are supported by a letter of credit (LOC)
from US Bank that expires April 2018. There is an 18-month term-out
period under the reimbursement agreement if there is a draw on the LOC.

Including Salem's fixed payor swap, Salem has 100% fixed-rate debt. The
swap is with UBS and the collateral posting threshold is $20 million.
Currently, no collateral posting is required.

Disclosure

Salem Health covenants to provide annual disclosure within 180 days of
fiscal year end and quarterly disclosure within 60 days of quarter end
for the first three quarters to the Municipal Securities Rule Making
Board's EMMA system.

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